Analysts seek out UK retail bargains as consumer outlook brightens

It might seem counter-intuitive on the same day that more dismal official retail figures and disastrous numbers from Debenhams coincided, but plenty of contrarian thinkers have already started looking to the retail sector for investment opportunities.

Thursday's report from the Office for National Statistics showed retail sales fell more than expected in March as consumers stayed away from shops amid snow and sub-zero temperatures swept in by the so-called Beast from the East. Sales were down 1.2% on the month and the quantity bought in the three months to March fell 0.5% from the final quarter of 2017.

Earlier in the week, however, the ONS revealed the first real wage growth for a year, as average weekly pay overtook consumer price inflation, with adjusted real wages now growing 0.3% above inflation in February. Inflation is expected to trend down further to be back to 2% by the end of 2018.

This creates the potential for a gradual improvement as we move into the second half of 2018 for consumer-related sectors based on the potential for real wage inflation and some easing off of prior pressures on margin and cost. While the improvement will be gradual, and could see consumers face higher interest rates from Bank of England tightening in May, the stock market is always a few steps ahead.

"While the UK consumer market backdrop is still constrained, it remains our view that rising living standards will help further improve consumer confidence," said Clive Black, retail analyst at Shore Capital. "With a period of sustained seasonal Spring weather we could see a release of pent up demand for consumer spending. Despite all the political and economic uncertainty, UK consumers continue to be resilient and today’s inflation data suggests more reasons than not, to be cautiously optimistic."

Jamie Constable at broker N+1 Singer overnight said that while fundamentals remain tough at present, the improved UK wage and inflation data, together with the recent strength of sterling, "make the case for a re-examination of retailers and other beneficiaries of a potential turnaround in consumer confidence spending".

Singer advised keeping a watch on small and mid-cap retailers Boohoo, Dunelm, Findel, Halfords, N Brown, plus pub companies Marston’s and Greene King and restructured casual dining specialist Restaurant Group in particular, as sentiment improves.

In the wake of Debenhams collapsing profits, challenging trading conditions and higher exceptional costs, analysts at RBC Capital Markets said the results may be a small negative for the clothing retailers on the day but there was brighter times seen ahead.

"Given current trading should now improve we think this may create a buying opportunity for UK apparel stocks."

N Brown has full year numbers on 26 April and, encouraged by the pound's recovery to within 5% of pre-Brexit vote levels, the inflection in real wages and seasonal weather arriving, Constable said if the update is in line "the share price has scope to outperform significantly from current levels".

In a note about Debenhams on Thursday, Peel Hunt's retail team said they would "rather focus on structural growth stocks or market leaders with strong balance sheets, such as DFS, which offers exposure to consumer recovery at an attractive valuation, without the fear of failure".

Kate Calvert at Investec took the brave call of upgrading Debenhams to 'buy' on the view that the dividend cut "should enable management to address historic infrastructure under-investment quicker" and belief that better stock management and increasing concession income "should drive a profit rebound in FY19e".

Halfords and Superdry were both backed by analysts at Canaccord recently, saying on the former that the next financial year will "mark an inflection point in earnings" as currency headwinds subside.